Do you feel lucky punk? Do you? That is what I ask myself when I think about dip-buying this market. One of my indicators is suggesting that it might be time to buy the dip for a quick bounce.
Professionals know that mean-reversion works better in volatile markets than it does when markets are trending. The only catch is that sometimes the market doesn’t mean-revert, and you are holding long or short into a death spiral or melt-up. I am fearful that we are again ripe for a death spiral, like we saw in August of this year. However, If I ignore my intuition and focus on the odds, the odds favor a bounce here. Lucky for us, death spirals are uncommon while bounces are common.
This custom indicator simply counts the number of stocks that declined and then ranks the number against the previous numbers of the last 252 days. I call it the Decline Line indicator, or Decliners, for short. There is nothing magical about it, and it is not even really original, but it works. I really like this indicator because it is one of few that do better when the buys are made on the open, rather than at the close when the signal is triggered.
The Rules:
Buy SPY at the open if
- 2 days ago the Decliners indicator < 90
- Yesterday the Decliners indicator was > 90
Sell the long position at the close if
- The Decliners indicator < 20
No commissions or slippage included.
The graph above shows that tonight the indicator again closed above 90. It also shows all of the buy and sell signals for the past year. Technically, the system is long as of Friday’s open, but that doesn’t really matter much to us. We are just looking at probabilities.
Looking at 1.1.2010 to the present:
- SPY buy-and-hold yielded a compound annual growth rate of only 0.39%.
- Trading SPY using the Decliners indicator yielded a compound annual rate of 6.29%.
- Win % for the indicator is 69.23%.
- On average, it has taken 4 days for each trade to be closed.
- Average trade yielded 0.32%.
Looking at all SPY history:
- SPY buy-and-hold yielded a compound annual growth rate of 5.21%.
- Trading SPY using the Decliners indicator yielded a compound annual rate of 6.64%.
- Win % for the indicator is 65.23%
- On average, it has taken 5 days for each trade to be closed.
- Average trade yielded 0.39%.
The bottom line is that there is better than a 65% chance that SPY closes higher than tomorrow’s open, sometime over the next week.
Still, despite the probabilities, beware the death spiral. Look at late July and early August for an example.
Equity Curves:
The above graph is from 1.1.2010 to 10.3.11. Note the death spiral drawdown in August.
Note that the indicator has done well during the recent Bear Markets of 2008 and the current one, compared to the Bear Market of 2000.
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